Bond Markets Can Still Show Stock Markets How to Forecast the Future

by: ContraHour

Facts do not cease to exist because they are ignored.

-- Aldous Huxley

Before IPO, talking trader babies, moral hazards and internet bubbles... before 0% interest rates, option-ARMs, house flipping hair dressers and housing bubbles...before TARPs, 10% unemployment rates, QE 2.0s and commodity bubbles, the United States had a stock market would generally rise and fall with the normal ebbs and flows of the business cycle.

In these days of yore, bond yields directly competed with stock returns for the attention of investor affection. In those days, the bond market was thought to be smarter and more attuned to the business cycle. And since stock prices followed the business cycle, bonds could often fore-tell the future for stocks. Old, grizzled stock pros who had survived the 1970s bear markets, would often look to the bond market for guidance on the future of stock prices.

These veterans knew that falling interest rates were bullish for stocks as they were in 1982, when after several false starts, one of the greatest bull markets in history kicked off.

click to enlarge images

Bonds vs Stocks 1982


Likewise, these veterans understood that rising interest rates would have the opposite affect and generally spell trouble for stocks. For instance, in October of 1993, the veteran stock investors got a well-telegraphed warning when bond yields suddenly began rising as interest rates anticipated a Fed tightening. Stocks continued higher on their merrily way for several months until they snapped to attention and promptly fell four months after bond yields had bottomed.

Bonds vs Stocks 1994


And again, just a year later, bonds again telegraphed highs and lows in the stock market.

Bonds vs Stocks 1995


The grizzled veterans also understood what would happen if the stock market ignored the message of the bond market too long. They had gone through the October 1987 crash, when stocks closed their eyes, covered their ears and started yelling LALALALAL!, launching themselves to the sky.

Bonds vs Stocks 1987


Most of these veterans are long gone now, having been ridden out of town by high flying internet stocks, gravity defying home builders or other phenomenon that they could no longer understand. But just because they aren't around to warn young gun hedge fund managers or high frequency trading computers of the risks of rising interest rates, doesn't mean bonds won't have an affect on stocks.

As the veteran stock traders learned so well in 1987, the stock market can only ignore the bond market so long. And stocks have ignored the bond market for five months now as investors plowed back into the risk trade. But those rising rates will bite at some time. And as the wily veteran would say, it will probably happen sooner than anyone expects.

Bonds vs Stocks Today


The lessons of the bond market have long been lost among the circus of high frequency trading, put-selling hedge funds, activist Fed chairmen and single stock ETFs but they have not been forgotten. The bond market might yet show the stock market a thing or two about forecasting the the future.

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